Third time lucky: Goodrich Petroleum & Encana Corporation

Meet the next great American shale oil play – and two companies that are banking on it being a gusher

Jody Chudley is the author of The Punchcard Portfolio, a value-oriented newsletter with a focus on Canadian oil and gas stocks

Jan 9, 2014

by Jody Chudley

The Play

American oil production has had an incredible revival thanks to the combination of horizontal drilling and multi-stage fracturing. This has become front page news, and is no longer a surprise to anyone – at least it shouldn’t be.

The fact that the U.S. Energy Information Administration announced that the country would be the world’s largest oil producer by 2015 only underscores the fact that self-sufficiency may not be far off for a country where it was once, quite recently, unimaginable.

What might be surprising to many, however, is that this surge in production in the U.S. is due almost entirely to only two unconventional oil plays: the Bakken and the Eagle Ford. Indeed, of the 2.2 million barrels of horizontal oil produced in the U.S. today, 80 per cent is from those two places. But they may soon be joined by a third major play if the recent results coming out of the Tuscaloosa Marine Shale (TMS) in central Louisiana are any indication.

The TMS has been referred to as Louisiana’s “Eagle Ford” and no wonder. It is, after all, considered to be the source rock for the lower Tuscaloosa Sandstone and Austin Chalk formations, which have produced oil for decades. Like most horizontal plays, the industry has long known that oil existed in the TMS. And like most horizontal plays, the mystery was how to get it out economically.

The TMS attracted attention in 1997 when Louisiana State University’s Basin Research Institute released a study estimating that seven billion barrels of oil lay in place awaiting recovery. Oil in place of that size is an opportunity just waiting for a solution. And like the Bakken and Eagle Ford before it, horizontal drilling, multi-stage fracturing and some serious trial and error now appear set to release some of that giant oil prize. Meet two companies that are poised to be some of the biggest winners from that prize.

The Picks

Goodrich Petroleum (NYSE:GDP)
1-year total returns (C$): 83.4%

If an investor is looking for direct exposure to the TMS, the company of choice should be Goodrich Petroleum. At the end of 2012, Goodrich had virtually no reserves attributed to the play, but the company tipped the market to the fact that it felt very confident about the TMS in July 2013 when it announced the acquisition of a 66 per cent working interest in 277,000 gross TMS acres. That purchase brought Goodrich’s total acreage position to 320,000 net acres. In 2014, the company is going to allocate $300 million of its $375 million capital expenditure budget to TMS drilling. There is no turning back from that kind of commitment.

The key will be getting well costs down from $13 million per location to closer to $10 million. Goodrich’s 2014 drilling program will show if it can.

Encana Corporation (TSE:ECA)
1-year total returns (C$): -7.3%

Encana recently revealed its “getting back to winning” strategy that is aimed at turning around a share price that has languished under the weight of low natural gas prices. The new strategy for Encana involves shifting the company focus to its five high return oil and liquids rich plays. Those are the Montney and Duvernay in Canada and the DJ Basin, the San Juan Basin and, yes, the TMS in the U.S.

With 300,000 net acres, Encana has a similar position to Goodrich in the play, and it will spend a similar amount in 2014 trying to prove up those assets. But the fact that Encana, which has a diverse portfolio of assets, is willing to go so aggressively after the TMS is another telling sign that the play is about to hit the big time.

The Postscript

Neither Encana nor Goodrich has much production coming from the TMS as they enter 2014. But with a combined $600 million being spent by these two companies there this year, that could change very quickly. There are quite a few natural gas and “combo” horizontal plays in the U.S., but far fewer pure horizontal oil plays. The TMS could add one more to that list in 2014 – and if it does, these two companies and their shareholders will be better for it.